A critical part of any startup’s journey is fundraising. This can be particularly challenging in the very early days of building your startup, before you have any real traction, metrics or even a launched product. In the early days, you also do not have the money or time to dedicate to complex fundraising negotiations, documentation and execution. That is why an increasingly popular method of early-stage funding is the convertible (also known as a convertible instrument). A convertible is a contract that your startup can sign to raise money. When you sign a convertible, your startup receives an investment, but does not need to issue any shares at that time. It is called a convertible because the contract can convert into shares in your startup in the future (typically at the time you do an equity funding round). A convertible is typically signed by your topco. 

Clara Tip: There are many types of convertibles. If you are already involved in the startup ecosystem, you may have come across a set of different names like convertible note, SAFE or KISS. In this article we will focus only on SAFEs. 

A SAFE (which stands for Simple Agreement for Future Equity) is the most popular type of convertible for early-stage startups. It was originally created by Y Combinator in 2013. A typical SAFE sets out an investment amount, a valuation cap and a discount, but does not include a maturity date or interest. This means that it is possible that a SAFE investment may never be repaid if an equity funding round does not happen. It also typically does not carry any additional investor rights, such as an MFN right, participation right or information rights (see key features below for further details on what these terms mean), but these can be agreed to separately in a side letter with the investor.

Key features of a SAFE

• No shares are issued at the time a SAFE is signed and money is received.

• Investor typically receives a discount to the valuation of your startup at the next equity funding round. This is typically around 20 per cent, though it can vary from 10 per cent to 30 per cent in some cases. This is essentially compensation for the investors taking a risk by investing in your startup early and not receiving shares (and the enhanced investor protections that come with holding shares) at the time of the investment.

• In addition to the discount, the valuation may also be subject to a valuation cap. A valuation cap is the maximum valuation of that startup when calculating the conversion of the investment amount under a SAFE into shares. It can work instead of or alongside a discount (in which case, it is whatever valuation is lower between the discount and the cap). So, if an investor invests at a 20 per cent discount with a $3 million valuation cap and at the next equity funding round the startup is valued at $6 million, then the investor will convert at the $3 million valuation (i.e. an effective discount of 50 per cent). If the startup is valued at $3 million, the investor would convert at $2,400,000 (a 20 per cent discount) because that is lower than the cap.

• The valuation can be either on a pre-money or post-money basis.

• While some convertibles may carry interest, a SAFE typically does not.

• While some convertibles may have a maturity date, a SAFE typically does not. A maturity date means that if you do not do an equity funding round and convert the investment amount into shares by certain date (e.g. 18 months from the date of the investment) then the investor has the right to either require repayment (this is increasingly rare since it is widely acknowledged that startups will not have the money on hand to repay) or force a conversion into shares.

• Other rights may include:

• A “most favoured nation” (MFN) right, which grants the investor the right to upgrade their rights under the SAFE to any more favourable rights that are granted to other investors in future convertibles (e.g. a higher discount or lower valuation cap);

• A participation right, which grants the investor the right to invest additional money in the startup’s next equity funding round, typically either an amount equal to their investment amount under the SAFE or an amount proportionate to what their percentage shareholding would be in the startup once converted; and

• information rights, which require the startup to provide certain information to the investor about its business and financials (e.g. quarterly management accounts, annual audited accounts, right to inspect books and premises).

• None of the key rights of an investor need to be discussed or agreed at this stage. They will be negotiated as part of the next equity funding round that will be carried out by your startup.

Clara Tip: It is always better to try and keep all the SAFEs you sign on identical terms (other than investment amount). If there are any special rights that you feel you have to give to one of your investors (e.g. a large investor leading your SAFE round), then it is better to give those terms in a side letter and keep the format and terms of the SAFE as consistent as possible with all investors. This does not mean the side letter terms would not be known to your other investors (it is always a good idea to be as transparent as possible and disclose all terms), but it keeps the process for reviewing and signing the SAFEs easier and highlights that any special terms are only given to specific, large investors and are not to be expected by most of your SAFE investors. Keeping all the conversion mechanics the same will also help you a lot when you come to convert all the SAFEs and run the calculations needed to figure out how many shares to give to each investor.

TL;DR

1. SAFEs are a quick and simple way for your startup to raise funds.

2. You will typically avoid a discussion on your startup’s valuation (other than agreeing a cap) and what investor terms you have to give (other than any agreed at the SAFE stage, such as MFN right, participation right or information rights).

3. There are many types of convertibles. The most common type among early stage startups is the SAFE. Others include a convertible note, KISS or fixed percentage equity convertible.

4. Try and keep the terms of all your SAFE terms as similar as possible.

5. Take a hard look at your company capitalisation (or fully diluted capitalisation), including whether it is one a pre-money or post-money basis.

You can create your SAFE on Clara in a few easy steps:

1. Sign-up on the Clara platform.

2. Click on Generate Documents.

3. Fill out some basic information about the company and the investor.

4. Choose the investment terms (e.g. cap, discount, investment amount, investor rights).

5. Click on Generate.

6. Send to all parties for signature through our built-in DocuSign.

7. Automatically see the SAFE stored in the data room and the equity position reflected on your cap table – no further data entry needed

Click here to create your SAFE on Clara